Why Investors are Returning to Brazil for Profits

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Recent upticks in Brazilian stocks have intrigued investors into revisiting this Latin American powerhouse.  Unlike other recovering stock markets, the real fundamentals behind Brazil are strong.  Since 2008, Brazil has shown the world it is worthy of investment, posting stock market growth of an emerging market country, but the prudence of a developed nation in monetary and fiscal policy.

Brazil’s Brief Recession

Brazil entered into the global recession rather late, and it only stayed in a recession for a matter of minutes.  The economy contracted for two consecutive quarters, which is the official description of a recession, but emerged with a 1.9% growth rate in the second quarter of 2009 – which was well above estimates.  Brazil was the first of all the Latin American nations to emerge from the recession and one of the first of the G-20 to do the same.

At its greatest depth, the recession took 3% of growth off the Brazilian economy, still leading it into an annualized recession, but the country’s fundamentals have already brought it back to growth, positioning the country for a strong 2010.

Currency Bouncing

The Brazilian Real dipped against the dollar (as did most currencies) at the very beginning of the global financial crisis.  In recent months, however, the Brazilian Real has not only made up the deficit, but is now within 8% of its all time high set against the dollar in the summer of 2008.  Strong exports and a growing economy have put the currency in favor and helped sustain its commodity exports and solid internal consumer economy.

The Makings of a Strong Economy

One of the many reasons Brazil escaped the financial crisis without a hitch is its lack of reliance on foreign products or markets.  Brazil’s leading export is commodities, which makes up only 13% of the country’s economic output.  While prices for commodities were not as high as they were in 2009, Brazil still benefits from a recession-resistant commodity-backed economy.

However, comparing Brazil’s economy to another similarly strong economy, China, would be a misstep.  Even the economic powerhouse that is China has 40% of its economy relying on the consumer strength of other nations, mostly in consumer products and industrial goods.

Brazil’s central bank has a strong hand in fiscal policy and is keeping inflation controls in check.  All these efforts maintain the business cycle which is quickly advancing Brazil to first world status.

An Emphasis on Monetary Policy

Latin American nations are known for political and economic instability, as well as high inflation.  However, Brazil has controlled inflation through high rates from its central bank.  Currently, the benchmark rate stands at 8.75%, and investors are expecting an additional hike of 1.75% by 2011, showing that Brazil intends to remain tough on inflation.  This strong stance against inflation has helped Brazil keep its bonds in investment grade territory, a true reflection of its economic strength and a rare achievement for an emerging market.

Monetary policy is known to make or break Latin American nations, which have a long history of default.  In seemingly every deep recession, one or two Latin American nations either default on their debt or experience hefty inflation as governments attempt to bail out their debt by devaluing the currency.  Brazil has not fallen into this trap.

Brazilian Options for American Investors

Exchange-traded fund issuers have taken a keen eye to Brazil’s economic success.  Two exchange-traded funds allow investors the opportunity to not only invest in Brazilian stocks and its economic strength, but also in its currency.

The iShares MSCI Brazil Index (EWZ) offers strong Brazilian stocks at developed market prices.  The exchange-traded fund trades at just 15 times earnings in a basket of the best stocks chosen by MSCI.  Year to date, the exchange-traded fund has nearly doubled.  Analysts expect the country still has some steam left, fueled by firm economic policy and an economy that is leading the world out of recession.

Investors looking to play the fundamentals have the WISDOMTREE DREYFUS (BYZ) fund, which is up 30% year to date on a strong Brazilian Real and offers the chance to benefit from Brazil’s growth without the volatility that comes with most emerging economies.  Although the currency is lagging behind the growth of the Brazilian stock market, the true run in price should occur as the rest of the world stabilizes and energy prices continue their ascent off credit crunch dips.